The FDIC’s Bank Deregulation Play

More often than not major shifts in public policy arise not from great debate in the halls of Congress but through the actions of some part of the vast bureaucracy of the United States government. The decision by Sheila Bair and the FDIC to sell Bank United of Florida to a consortium of private equity players may mark such a policy change.

Earlier this week, Bank United was seized by the FDIC and sold to a consortium of private equity firms. The acquirers included WL Ross & Co. LLC, Carlyle Investment Management L.L.C., Blackstone Capital Partners V L.P., Centerbridge Capital Partners, L.P., LeFrak Organization, Inc, The Wellcome Trust, Greenaap Investments Ltd. and East Rock Endowment Fund. Details of the transaction can be found at the FDIC’s website. The short version is that the companies mentioned above formed a new company which they capitalized with $900 million and and into which the FDIC transferred most of the assets and deposits of Bank United. The FDIC entered into a loss sharing arrangement with the acquirors.

It’s all pretty standard stuff with the exception of the nature of the business of the acquiring companies. They are all private equity players. This actually marks the second acquisition of a failed bank by private equity. IndyMac was sold last fall to a consortium of private equity companies that included funds controlled by Christopher Flowers, George Soros and Michael Dell.

One thing that you might note about both deals is that they’re split among a group of PE companies. On its face, that’s a bit peculiar because the investments are of a size that could easily be swallowed by any one of them individually. There is good reason why all of them are acting in concert.

The bank holding company laws deem any ownership of a depository institution in excess of 25% to constitute effective control. Once an individual or company passes this threshold they are subject to supervision and regulation by the Fed. Not something that most PE companies relish, hence they split the deal amongst themselves in order to stay under the limit. The Fed has not spoken publicly about this sort of arrangement but according to the NYT they have told the companies privately that they consider the arrangements to be nothing more than a subterfuge.

So why should all of this matter? Well, the U.S. has a long history of not allowing commercial enterprises to own or control banks. The theory being that such control could lead to unacceptable concentrations of economic power as well as call into question the independent assessment of credit risk if the banks were to extend credit to related entities. In fact, during the early part of the twentieth century such concentrations of power did exist and led to the enactment of laws to prevent the abuses that arose.

Which brings us to the current situation. The PE guys naturally argue that times are different now, that there is more and better bank supervision and they can wall off the banks so that they won’t veer off into undesirable activities. They also suggest that the amount of money they can bring to the table to recapitalize the banking system is substantial and given the needs they should be allowed a seat at that table. Whether they would in fact operate in this matter might be a matter for conjecture save for the recent history of the ownership of two Japanese banks by PE firms.

As detailed in a Bloomberg article, two Japanese banks Shinsei and Aozora were acquired a few years ago by American PE firms; Shinzei by Christopher Flowers (one of the buyers of IndyMac) and Aozoro by Cerberus (the owner until recently of Chrysler and GMAC). Both invested heavily in overseas transactions sponsored by their PE owners and both paid a heavy price. Shinsei has booked over $1 billion in losses related to investments in Lehman Brothers and Hypo Bank, a troubled German real estate bank. Aozora is suffering as well having taken losses on investments in subprime mortgages, GMAC and Bernard Madoff’s funds.

So now the FDIC has elected to turn decades of banking law and practice on its head. Admittedly, the sales appear to conform to the rule of law but so have so many of the other abuses that have come to light recently. The agency has indicated (link here) that it might soon release some policy guidelines for the purchase of failed banks by private equity firms. In other words, having arguably exceeded its authority already, the FDIC intends to legitimize a suspect experiment via regulation.

Whether PE should be allowed to own banks is a topic that should be open for debate. In fact, it properly belongs within the debate that we have all been promised but have yet to see or hear concerning the changes needed to shore up a suspect banking system. There seems widespread agreement that the discussions will involve new and more active regulation. Therefore, it seems somewhat incongruous that the FDIC should be unilaterally engaged in what amounts to deregulation at this point in time.

more: here (WSJ On The Topic Of PE Buying Banks) and here (John Hempton On The Same Subject-Highly Recommended)

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